The exchange rate denotes the price of a domestic currency value as overseas money. In any economy, the aspect of interchange rate plays a vital role in influencing the economy. For a country to attain economic growth, stability, and economic development, the element of the exchange rate is a crucial determinant. Moreover, the exchange rate directly influences financial aspects such as inflation, unemployment, and external competitiveness. There are four main types of exchange rate regimes. However, this paper will focus on a debate on the two primaries: fixed exchange rate and floating exchange rate regimes.
Fixed exchange rate regime
In finance, the term fixed exchange rate is used when a nation’s monetary authority or the chief bank wants to retain the worth of its currency constant compared to other countries’ currencies. What happens is that the currency’s value is maintained constant with a predetermined range when using the fixed exchange rate systems. Since fixed exchange rates are more predictable, they will most likely benefit importers and exporters (Stoykova, 2021). Economically, having a stable interest rate helps the government, especially during periods of low inflation. Therefore, it is crucial to note that common interest rates lower interest rates over the long term while promoting investment and all relevant economic activities.
Advantages of fixed exchange rate
With a fixed exchange rate, no reserves will be lost due to a rise in debts. When exchange rates are at liberty to vary freely, it is cautioned that they should never be allowed to remain excessively high or excessively low for a very long period. If demand and competitive advantage change gradually, the currency value is expected to fluctuate based on the market conditions leading to overvaluation or undervaluation. From an economic point of view, government incentives may be affected by all existing external forces if they lack excess liquidity on hand to cover any financial shortfalls or sustain exchange rates (Sitompul et al., 2021). Therefore with an increase in such a deficit, the exchange rate will re-establish a state of equilibrium; hence no reserves will be lost due to the rise in debt
Additionally, fixed foreign exchange streamlines the process by eliminating all ambiguous processes and risks. By doing so, the currency rate is stabilized, and such is a prerequisite for orderly and constant economic growth, promoting commercial activities. Notably, any fluctuation in the dollar’s value is likely to have a detrimental effect on the plans and programs of importers and exporters. When a country does not need a large official foreign exchange reserve, resources in the foreign currency that would otherwise be kept in an account are allocated elsewhere rather than retained (Sitompul et al., 2021). Thus having a static foreign exchange rate keeps the currency exchange rate stable.
Floating Exchange Rate Regime
A floating exchange rate is a structure in which the money value of a nation is established by overseas exchange markets grounded on the quantity and claim of such currencies. One can quickly note that this divergence with the fixed exchange rate in which the administration has total dominance determines the exchange rates. In floating exchange rates, there are free fluctuations. As a result, the government may not have any say in deciding the interest rates (Bénétrix & Lane, 2021). The currency fluctuation over the long term reflects the economic strengths of the nation’s economy and stated interest rate differences. Economically, catastrophes, rumours, and speculation play a significant role in short–term movement in floating exchange rates. Indeed, the currency values fall when their supply exceeds the demand. Short-term movements can lead to the central bank intervening during the floating rate regime. However, even if most global currencies are free to move, the government and the central bank have the authority to intervene in a case where one country’s currency depreciates or appreciates in an unreasonable manner
Advantages of Floating Exchange Rate Regime
With floating exchange rates, a change in any rate is immediately rectified, and any imbalance in payment balance is handled. For instance, if a nation has a payment deficit, its currency will devalue, keeping all other factors constant. Due to that, exports will be more affordable, boosting their demand. On the other hand, imports will be more costly, reducing their need (Beatrix & Lane, 2021). Due to having a free-floating exchange rate, it will be easy to restore a state of equilibrium in the balance of payment. Considering a situation with a positive payment balance, the currency exchange rate fluctuation will immediately erase the surplus.
On top of that point, having a floating exchange rate free exchange is unrestricted. By removing foreign exchange restrictions, internal policies can run more smoothly. The floating exchange rate system allows government trade balance deficits to be closed by adjusting all external currency prices. Examining the fixed exchange rate, the entire economy can easily result in undesirable economic effects such as unemployment and a lot of idle capacity of locally available natural resources (Bénétrix & Lane, 2021). Many economists have argued that the main reason why some countries prefer fixed foreign exchange rates is due to the absence of a link amongst trade balance fluctuation and exchange rate movement in the monetary discipline.
Criteria for choosing the best system in international business
From an international business point of view, there are specific criteria for choosing which system is best. In most cases, fixed exchange rates are preferred in the circumstances with massive fluctuations. Suppose the government needs to achieve economic stability. In that case, it must maintain constant foreign exchange rate parity to prevent the money supply from increasing g ta a higher rate leading to inflation. Also, it has been argued that a fixed exchange rate prevents all speculative behaviors (Ilzetzki et al., 2021). Truly, establishing a stable interest rate helped to improve the global trust. As a researcher, critics have arisen as to whether altering the trade balance had any change in currency rate.
On the other hand, monitory policy independence and automatic changes to the trade balance call for floating exchange rates. Notably, currency depreciations likely lead to cheaper exports and more costly imports, reducing the existing trade imbalance. To a large extent, the method that works best in foreign busies is determined by personal preferences (Ilzetzki et al., 2021). It should be noted that even though alternative fixed exchange rate regimes are small tables, they provide security, promoting quicker development in international commerce and investment growth.
Most desirable system for international business
Due to unavoidable reasons such as speculations, uncertainties, absence of links between trade balance and foreign exchange rate volatility, and monetary discipline, fixed exchange rates are warranted. Thus, I mean that fixed foreign exchange rates are more preferred. As governments abide by the monetary discipline, they must maintain a constant foreign exchange rate so that the money in supply does not rise at an inflationary rate (Ilzetzki et al., 2021). Indeed, setting a fixed interest rate is likely to reduce volatility in the international financial system without exterminating any uncertainties, which in return helps to boost global business confidence. Additionally, one can easily make a rational observation that monetary policy and automatic trade adjustments are critical reasons for a fixed exchange rate regime. Economically, the need to maintain an exchange rate parity thwarts a country firm from responding to circumstances by either decreasing or increasing the monetary supply. Therefore, based on the two techniques, it can be conducted that a fixed exchange rate regime is preferable in international business based on my taste. This is because the floating exchange rate system is less durable and unstable and may not work.
In conclusion, the paper has deeply analyzed the concept of exchange rate based on the two main types: fixed and floating exchange rate regimes. It has also cored merits of each type. In choosing the best system in international business is, very crucial substantiating information has been analyzed to give a proper understanding of why the fixed exchange rate is better than the floating exchange rate and the grounds for choosing any of the systems
Bénétrix, A. S., & Lane, P. R. (2021). Fiscal shocks and the real exchange rate. 32nd issue (September 2013) of the International Journal of Central Banking.
Ilzetzki, E., Reinhart, C. M., & Rogoff, K. S. (2021). Rethinking exchange rate regimes (No. w29347). National Bureau of Economic Research.
Sitompul, S., Ichsan, R. N., & Nasution, L. (2021). The Influence of Exchange Rate, Inflation, For the Results of the Development Assets of Islamic Banks.
Stoykova, O. I. (2021). How do we increase the value of bilateral trade? Currency union versus fixed exchange rate regime. Entrepreneurial Business and Economics Review, 9(2), 21-38.